The Future of Payments

102 BANKING PERSPECTIVES QUARTER 4 2018 The Bank Conditions Index (BCI), which provides a summary measure of the condition of the U.S. banking system, rose in the second quarter of 2018, as shown in Exhibit 1. The elevated values of the index show an extremely resilient U.S. banking system, reflecting in large part the very strong capital and liquidity positions of banks as well as a very prudent stance on loan originations. Over the last few quarters, the index registered modest declines, driven mostly by changes to the U.S. tax code. This quarter, improvements in the BCI were seen across almost all categories of the index. The profitability and capital categories rose mainly because of the lower corporate tax rate, and risk aversion remained somewhat elevated, as shown by the negative gap between loans and GDP. Overall, the BCI remains well above the level that maximizes the contribution of the index in tracking future GDP growth, suggesting that risk aversion by banks or banking regulations continues to be holding back economic growth somewhat. Exhibit 2 depicts the heat map of the BCI for each of the six categories that make up the aggregate index. Values near 100 (higher resiliency) are shown in blue while values near 0 (higher vulnerability) are shown in red. Overall, most of the six subcomponents of the BCI – capital, liquidity, risk aversion, asset quality, interconnectedness, and profitability – became more resilient in the second quarter of 2018. In particular, capital, risk aversion, asset quality, interconnectedness, and the profitability categories showed improvements in their degree of resiliency. Only the liquidity category experienced a very modest decline in the degree of resiliency this quarter. The increase in the resiliency observed in the capital category was driven by an increase in regulatory capital ratios. Over the past couple of quarters, regulatory capital ratios declined at banks, in part driven by recent changes to the U.S. tax code. In particular, the common equity Tier 1 ratio rose to 12.0% in the second quarter from 11.6% in the first quarter. The rise in regulatory capital ratios was more pronounced for risk-based ratios compared with the Tier 1 leverage ratio. This suggests that the increase in resiliency in regulatory capital was driven both by an increase in retained earnings as well as a decrease in the riskiness of bank assets. There is also very little evidence of a build-up of vulnerabilities in the banking sector. Specifically, the risk- aversion category also rose in the second quarter, driven by a decline in the loan-to-GDP gap. Currently, the gap is well below its long-run trend and declined further in the second quarter, signaling a lackluster growth rate of loans relative to the size of the economy. The softness in bank lending appears to stem in part to substitution to the non-bank sector, including the corporate bond market, as borrowers seek to lock in low long-term rates. Indeed, the credit-to-GDP gap – which includes the supply of credit in the U.S. economy from both banks and non- banks – continued to close as of the end of 2017, although Bank Conditions Index EXHIBIT 1: AGGREGATE INDEX OF RESILIENCE OF THE U.S. BANKING SYSTEM BPI* Q2 0 25 50 75 100 1995Q1 2000Q1 2005Q1 2010Q1 2015Q1 QUARTER RESILIENCE Note: BPI* denotes the estimate of the optimal level of the BCI, that is the value of the index that maximizes the contribution of the BCI in tracking future GDP growth. Source: BPI Calculations